The Bank of Canada’s decision to leave its key overnight interest rate at five per cent in October was driven by factors including conflict in the Middle East that risks keeping oil prices elevated and federal and provincial government spending that “could get in the way of returning inflation to target.”

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The six-member Governing Council, led by central bank governor Tiff Macklem, began meeting Oct. 17 and discussed a number of concerns including the risk of inflation expectations becoming entrenched. According to a statement of deliberations released Nov. 8, they also concluded that continued wage increases at the current pace of four per cent to five per cent would be “inconsistent” with restoring price stability.

However, the central bankers also discussed signs that raising interest rates over the past year and a half was working to slow the economy and tamp down inflation.

Consumer spending has been weaker than expected, for example, with household credit growth declining “substantially” as Canadians adjust to higher borrowing costs. 

Third-quarter assessments also suggested weakness in spending on housing and durable goods with a spread to services. Meanwhile, they anticipated that exports would stall as foreign demand softened, with businesses reporting softer investment intentions due to elevated funding costs and weaker sales prospects. 

But while inflation has begun to moderate in certain areas including food, several factors were standing in the way of the disinflationary process, the central bankers concluded, according to the statement of deliberations. These included higher gas prices driven by elevated global oil prices, a main factor in the rebound of inflation since June.

Shelter price inflation, meanwhile, was running around six per cent, partly due to rising mortgage interest costs following interest rate increases but also evident in rent and other housing-related costs. 

The central bankers said Canada’s ongoing “structural shortage” of housing was getting in the way of a typical scenario where higher interest rates normally exert downward pressure on house prices and other costs that are closely linked to house prices, such as maintenance, taxes and insurance. In addition, the rapid increase in Canada’s population had added to the existing imbalance between demand and supply for housing, the central bankers said. 

They also concluded that near-term inflation expectations and wage growth remained elevated, and while corporate pricing behaviour was “normalizing,” it was doing so only gradually.

“Together, these factors were contributing to persistence in inflation,” the central bankers concluded, noting that core inflation has been stuck in a range of 3.5 per cent to four per cent for the past year.

As a result, Governing Council members revised their forecast for inflation upwards in the near term.

“The lack of downward momentum in underlying inflation was a source of considerable concern,” according to the statement of deliberations, which said the two possible explanations for this persistence were that the transmission of monetary policy actions through to inflation required more time, or that monetary policy was not yet restrictive enough to relieve price pressures.

“Members discussed whether the stickiness in core inflation measures reflected the fact that excess demand remained in the system or that inflation could be becoming entrenched.” 

If that is the case, the central bankers acknowledged that further rates hikes would likely be required to restore price stability.

Despite these concerns, with a weaker growth outlook and more excess supply, the central bankers continued to expect inflation would return to the two per cent target in 2025.

During their deliberations, the Governing Council members also discussed aggregate spending plans of federal and provincial governments, which are projected to increase at an annual pace of roughly 2.5 per cent in 2024, which could make it more difficult to rein in inflation to the central bank’s two per cent target. 

“If all those plans are realized, this would contribute materially to growth over the next year,” the statement of deliberations said. “By adding to demand at a faster pace than the growth of supply, government spending could get in the way of returning inflation to target.”

The Bank of Canada paused interest rate hikes on Oct. 25 for the second consecutive time, keeping the key overnight rate at five per cent. 

Macklem acknowledged then that the runway for a soft landing was narrowing, with low growth forecasts for the coming quarters that could easily turn negative. 

Since the latest rate decision was made, certain early economic indicators for the third quarter have suggested the Canadian economy has slowed. Statistics Canada released early estimates that suggested gross domestic product was flat or marginally down in July, August and September, with updated figures expected Nov. 30.

The central bankers spent a considerable amount of time discussing global financial conditions at the meetings before their latest rate decision, including a noteworthy rise in bond yields, according to the statement of deliberations.

Among the possible reasons for this rise, they concluded, were market assessments that central bank policy rates would remain higher for longer, and investors seeking greater compensation for volatility in long-term rates. They also considered whether continued deficit financing in the United States was leading to a large supply of U.S. Treasuries, together with fewer buyers and quantitative tightening, and the possibility that the neutral rate may be drifting higher.  

• Email: bshecter@postmedia.com

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